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How to Save Capitalism: Treat Employees Better – Part 1

Several months ago, a friend had argued that, after the collapse of communism as an anti-thesis, capitalism had no reason to favor the labor force anymore. We don’t know whether he was the original owner of this idea or he had read it somewhere. Nevertheless, given the increasing inequality and rising populist waves around the world, this was a striking argument and clearly worth thinking about it. 

We have previously written about the inequality debate in this years’ Davos WEF meetings. At that time, we have argued that the current corporate governance system, which awards the high-level management, sometimes at the expense of regular employees, could be the key cause of the problem. Today we will further explore the subject, in light of economic data. 

We will employ the US data here for several reasons: (1) the extent of data, which is like the Disneyland(*) for economists, (2) the facts that US being kind of synonymous with capitalism and (3) that Mr. Trump’s victory being the current and hardly contestable pinnacle of populism. 

All the figures below are annual data in current dollars, unless noted otherwise. We have indexed them as 1965=100, in order to eliminate the differences in scales. 

The first two graphs compare the growth rates of overall vs. per capita GDP. The left-side shows that overall economic growth had outpaced the increase in GDP per capita, during the past 50 years. Furthermore, the divergence seems to have picked up speed during 1980’s, the decade during which USSR was collapsing(**) However the left side suggests that the difference in growth rates of two series were continuously declining through past 50 years (***). This may be due to declining growth in population, as the denominator of per capita GDP.  However, these pictures are yet far from giving us a convincing evidence about our question at hand. 

Next, we try to understand whether the corporate sector was indeed not favoring the employees since 1990’s. First we compare the development of corporate profits against overall economic growth. Here, we can see that corporate profits have started to outpace GDP growth since late 1980’s and then sky-rocketted since early 2000’s.

Such a great increase in corporate profits should not be a bad thing for any country, as long as it is distributed fairly (not necessarily equally). Let’s see if it is the case for the US. 

The next graph plots the past 50 years of corporate profits vs. compensation of employees. The picture is quite similar to what we have seen above. Corporate profits grow higher than compensation since 1985 with an almost uninterrupted increase in difference. Here, we should note that the compensation of employees in the National Accounts includes all employees, i.e. CEO’s, as well as regular workers.

The only disruptions in the break-neck speed of corporate profit growth during the past 35+ years, were crisis periods. We can count the China’s accession in the WTO, at least as a factor that contributed to the resumption of the trend in 2000’s, if not the leading cause. 

The corporate growth trend since late 80’s did not seem to lead new jobs either. The graph below, shows that neither of these show an upwards break, similar to corporate profits, during the period we analyze. In fact, second order polynomial trend show that job creation is slowly decreasing, while number of firms seems to fare better. 

To summarize, we see a clear break in wealth distribution structure in the US, since mid-80’s. This break is also reflected in the shares of different income strata within the economy. The lower 60% of the economy is clearly and continuously losing ground against the upper 40% (****) . Consequently, the Gini Index shows a sudden shift in 1990, which is confirmed by Chow break test we have run on the linear trend. 

Of course, we would never argue that the structural break in the corporate profit growth, since 1990’s, was only due to the fall of communism. The past 30 years have seen big transformations in the global economy; globalization, technological advance, the rise of China and productivity gains being among the first ones that come to mind. Nevertheless, the timing of the take off in corporate profit growth is quite note-worthy, even it is a mere coincidence. Whatever the reasons are, there is a certain break.

All-in-all, the low and middle income class were unhappy about the current establishment and income distribution, so they have elected Mr. Trump the challenge it. Rulers of the corporate world, which did not voluntarily share the wealth with lower levels of income until now, are already feeling the arm-twisting from Mr. Trump. We will curiously monitor what will be the turn of events, in the coming months and years. 

The better income distribution is only one part of our argument that capitalism should treat better to employees, in order to survive. We will talk about the changing worker profile and their different motives in Part-2: Watch out, the millenials are here…!

(*): Being in Disneyland can be both great and painful. Children can be easily confused about which parts to visit, in their limited time. Similarly, dealing this much data contains the risk of not looking every available indicator, thus maybe being led to false conclusions. 

(**): Although USSR has officially ended in 26 December 1991, setting the date of the collapse in one particular year would not be the best choice. Today, historians prefer different intervals, which cover at least between 1985-1991. Thus, we generally look for a structural break in US data between 1980-91, rather than only 1991. 

(***): The GDP-income difference seems to have stalled decreasing during 1980’s. This is particularly interesting, since this was the period of Reaganomics, which is today being likened to economic plans of Mr. Trump. 

(****): One can argue that the wealth of American people can not only be measured by wages or total compensation, given the countless investment opportunities and capital gains. Having lived in the US for two years, we can comfortably say that higher levels of income were the ones, who mostly enjoyed those opportunities. Anyways, we all know how it ended in 2008, after the years that lower levels of income were increasingly included in Wall Street gimmicks.